Capital Flight and Bitcoin Regulation

• Date: 01 September 2016
• Author: Zhiyong Tu,Lan Ju,Timothy (Jun) Lu
• Published date: 01 September 2016
• DOI: http://doi.org/10.1111/irfi.12072

Capital Flight and Bitcoin

Regulation

*

LAN JU,TIMOTHY (JUN)LU AND ZHIYONG TU

Peking University HSBC Business School, University Town, Nanshan District, Shenzhen

518055, China

ABSTRACT

This paper studies the risk of Bitcoin being used for the purpose of capital

flight. We propose a new indicator, the bitcoin-implied exchange rate dis-

count, to identify empirically capital flight via Bitcoin. Using data from the

two largest bitcoin exchanges in the world during our sample period, BTC

China and Bitstamp, we find strong evidence of capital flight from the Chi-

nese Renminbi to the US Dollar via Bitcoin before the People’s Bank of China,

China’s central bank, announced its regulatory policy on December 5, 2013,

while the evidence displays no trace of capital flight after the announcement.

The People’s Bank of China’s Bitcoin restriction policy successfully halts the il-

licit capital outflow via Bitcoin, thereby providing valuable policy implications

for government regulation on Bitcoin, as well as on other virtual currencies.

I. INTRODUCTION

Bitcoin is probably the most successful—and probably the most controversial—virtual

currency scheme to date (European Central Bank (ECB) 2012). Based on a decentralized,

peer-to-peer system, Bitcoin operates at a global level and can be used as currency for a

variety of transactions for both virtual and real goods and services. Over the past few

years, the increasingly wider adoption of bitcoins in everyday business also reveals some

of its inherent risks, which draws the attention of regulators around the world.

The ECB (2012) report warns of the potential risk that criminals, fraudsters,

and money launderers could use Bitcoin to perform illegal activities. Most gov-

ernments in the world impose some restrictions on Bitcoin. For example, China

announced on December 5, 2013 that bitcoin transactions were prohibited for

financial institutions and payment companies, while individuals could still trade

bitcoins. A few countries enforced full prohibition of Bitcoin. For example,

Iceland banned bitcoin transactions because of the capital controls put in place

in 2008 to stop money flight on the króna.

1

*We thank Professor Ramazan Gencay and the anonymous referee for their helpful comments and

suggestions. We also thank the support from the HSBC Financial Research Institute at Peking Univer-

sity. This article is for consideration for the Letters Section.

1 The legality of Bitcoin by country can be obtained from http://www.bitlegal.io/, a website that

provides regulatory information regarding Bitcoin around the globe.

© 2015 International Review of Finance Ltd. 2015

International Review of Finance, 16:3, 2016: pp. 445–455

DOI: 10.1111/irfi.12072